The Callable Bond

Callable bonds offer investors enhanced yield, but carry risks that are not present with non-callable bonds. When a bond is callable, it means that the issuer is entitled to retire the bond by returning the principal to the bondholder. While there is usually an initial, non-callable period, after this date has past, your bonds may be called at any time. When this occurs, you will receive a specified price for the bond and interest payments will stop.

Risk

The primary risk that this creates is called reinvestment risk. When rates rise, bonds are rarely called because the issuer is content to make the interest payments, rather than borrowing at a higher rate. When rates fall, however, bonds are called. The company can now retire a portion of its debt and issue new bonds at a lower interest rate.

The risk to the investor is that if your bonds are called, you now must reinvest the money in a lower interest rate environment. The presence of this risk is why these bonds tend to pay an enhanced yield, called a risk premium. Callable bonds can be attractive for this reason, but you should have a solid opinion of the interest rate environment before you invest, so that this can be factored into your investment decision.

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